In Olson v. EV3, Inc., et al., C.A. No. 5583-VCL (Del. Ch. Feb. 21, 2011), the Court of Chancery addressed the issue of a post-settlement fee petition for a plaintiff who challenged the use of a top-up option to facilitate a two-step acquisition. In what Vice Chancellor Laster described as "the first meaningful full-scale challenge to the use of a top-up option…that raised novel issues," the Court awarded plaintiff’s counsel $1.1 million which was the full amount requested by plaintiff. As a side note, Vice Chancellor Laster provides a very helpful discussion on the background and purpose of top-up options as well as the limited legal precedent that existed before this decision was rendered.
This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.
Background of the Merger
Defendant ev3, Inc. and Covidien Group S.a.r.l. entered into a merger agreement where Covidien, (through a wholly-owned acquisition subsidiary), would acquire ev3 through a standard two-step acquisition, using a top-up option if certain conditions were met. Pursuant to the agreement, in the first step, Covidien would offer to purchase ev3’s outstanding shares for $22.50 per share in cash. After the first step, if Covidien owned a majority of ev3’s outstanding shares, then the parties were contractually obligated to complete the second-step merger which meant that all remaining ev3 stockholders would receive the same consideration, subject to their right to seek appraisal. Section 1.4(a) of the merger agreement provided Covidien with an irrevocable option to purchase, at a price per share equal to the tender offer price, a number of shares that when added to the shares owned by Covidien and its affiliates would constitute one share more than 90% of all outstanding shares. Section 1.4(b) of the merger agreement provided that Covidien could pay for the Top-Up Option Shares in cash or by delivering a promissory note with its "terms to be set in the future and determined in the first instance by Covidien." (emphasis in original).
The Litigation, the Quick Settlement and the Issue of Fees
On June 18, 2010, a complaint was filed seeking a preliminary injunction blocking the transaction on the grounds that: (i) the Top-Up Option failed to comply with Sections 152, 153 and 157 of the DGCL; (ii) the exercise of the Top-Up Option would coerce stockholders to tender because of the threat of "appraisal dilution"; (iii) the ev3 directors breached their fiduciary duties in granting the Top-Up Option; and (iv) Covidien aided and abetted their breach. A motion to expedite was granted because the Court found that, among other reasons, "the complaint advanced a strong claim that the Top-Up Option…failed to comply with Sections 152, 153, and 157 of the DGCL". So if the "second-step of the Merger using shares received through the exercise of an invalid option, then the Merger itself would be subject to attack as ultra vires and void." Discovery ensued and within a short period of time, the parties reached an agreement to settle the matter. A memorandum of understanding dated June 2, 2010 (the "MOU") was executed.
As the Court noted, "[a]lthough the settlement was reached quickly, it provided the plaintiff with all the relief she could have hoped to achieve on the merits." Pursuant to the MOU: (i) Section 1.4(b) of the Merger Agreement was amended to specify the material terms of the promissory note and mandated that the par value of the Top-Up Shares be paid in cash; (ii) the MOU required that the amendments to the Merger Agreement be approved by the ev3 board of directors at a meeting where the terms and operation of the Top-Up Option were thoroughly reviewed and the necessary statutory determinations made; and (iii) Section 9.1 of the Merger Agreement was supplemented to prevent any amendment of Section 1.4 in a manner that would adversely affect the rights of other ev3 stockholders after Covidien became a majority stockholder. The agreement also provided that the shares issued under the Top-Up Option and any related consideration would not be considered for purposes of appraisal. Having reached agreement on the substantive terms of the settlement, the parties next then turned to the issue of attorneys’ fees. Unfortunately, they could not agree on an amount—plaintiff’s counsel sought an award of $1.1 million; defendants offered $525,000.
In determining a fee award under Sugarland Industries, Inc. v. Thomas, 420 A.2d 142 (Del. 1980), Delaware courts "‘assign the greatest weight to the benefit achieved’" in light of the nature of the claims and the likelihood of success on the merits. Secondary factors include the complexity of the litigation, the standing and skill of counsel, and the contingent nature of the fee arrangement, together with the level of contingency risk actually involved in the case. While courts will look at the number of hours worked, it is only as a check "to guard against windfall awards." Here, the Court’s decision turns on its analysis of the primary factors identified in Sugarland Industries so the secondary factors will not be discussed in this summary in any detail.
Benefits Conferred By Eliminating "Appraisal Dilution" Were Ephemeral
The Court analyzed in detail the argument of "appraisal dilution" and the issues addressed in the case law regarding that topic, as well as Section 262(h) (the "exclusive of" language) as to whether "appraisal dilution" was a viable argument when addressing a Top-Up Option. The Court concluded that while the settlement agreement alleviated any threat of "appraisal dilution" because the shares issued under the Top-Up Option would not be considered for purposes of appraisal, the Court regarded that as a minimal benefit worth a fee award of $100,000.
Benefits Conferred By Remedying The Statutory Invalidity Issues Were Significant
The Court found that the litigation conferred a meaningful benefit on ev3 and its stockholders by addressing the statutory problems with the Top-Up Option. The merger agreement originally failed to set forth the consideration to be paid for the shares or a formula by which the consideration could be determined. Section 1.4(b) of the merger agreement authorized the consideration for the Top-Up Shares to be paid with a promissory note, but failed to set forth the material terms of the note. Section 1.4(b) expressly contemplated that the material terms would be set in the future "‘on terms as provided by the Parent or the Purchaser, which terms shall be reasonably satisfactory to the Company.’"
Section 157(b) of the DGCL requires that the option terms, including the consideration to be provided for the shares, be set forth in the certificate of incorporation "or ‘in a resolution adopted by the board of directors providing for the creation and issue of such rights or options, and, in every case, shall be set forth or incorporated by reference in the instrument or instruments evidencing such rights or options.’" The merger agreement failed to set forth not only the consideration to be paid for the shares or a formula by which the consideration could be determined, it also failed to specify any other terms for the promissory note. This raised the question of whether there ever was a board resolution. Discovery showed no such resolution. In addition, Sections 153 and 157(d) requires that the consideration to be received for shares with par value "have a value not less than the par value thereof." Because the terms of the promissory note were not set at the time the ev3 board attempted to grant the Top-Up Option, the board could not make this determination.
The Court noted that "[d]eep faults could have developed in the ev3 corporate structure if the Top-Up Option Shares were found invalidly issued and the Merger invalidly consummated. The settlement administered a preventative cure." First, Section 1.4(b) was amended to specify the material terms of the promissory note as required by Section 157(b).
No Benefit Conferred By Top-Up Disclosures
The settlement required disclosure of the amendments to the merger agreement and changes to the Top-Up Option. While the disclosures accurately described the substantive benefits achieved by the litigation, the Court found that they did not provide any incremental value so the Court awarded no fees for these disclosures.
Second, the settlement required that the ev3 board meet to approve the amended Merger Agreement and adopt an implementing resolution as required by Sections 152, 153(a), and 157(d), and that a board resolution would exist that provided for the creation and issuance of the Top-Up Option, as required by Section 157(b). Finally, Section 1.4(b) was amended to require that Covidien pay the par value of any Top-Up Shares in cash which eliminated any question as to whether the value of the consideration received for the Top-Up Option Shares was less than the par value of those shares, as required by Section 153(a). The Court found that "[t]he resulting benefit is non-quantifiable and immeasurable but in my view quite substantial. An award of $1 million is fair and reasonable compensation for a settlement that cured serious statutory flaws."